FX Consolidates But Market Still Favors USD

News and Events:

Safe haven trades were slightly stronger this morning despite some encouraging US data and an okay Irish debt auction. However, due to the low liquidity in Asia and Middle East, plus the summer & holiday atmosphere still infecting most of the G10 nations, market moves should be taken with a grain of salt. Yesterdays divergence between stock markets and EURUSD performance, highlights in our mind, the fact that traders are still heavily bearish EUR and to a lesser extent broader risk correlated FX trades.

Gold fell yesterday after a strong move this week – it failed to reach the highly awaited $1265 historic high – we believe the moves in Gold are most likely due to major players are consolidating in the near term. The move toward Gold by bigger players is the result of sovereign risk concerns still not being flushed out of the system. Once the lull in the market ends, the summer risk takers may sell off their risky assets.

The problem lies with the immediate concern that EU banks are undercapitalized and might need a decent shoot of extra liquidity plus longer term structural reforms. While ECB Governing Council member Mersch stated yesterday that there were broad based recovery signs across Europe, we disagree as we cannot imagine any “EU growth” without Germany being the core driver of that growth. But then again, Central Banks always need to put on a positive face. Admitting to a broad based slowdown will only aggravate a very unsettled situation.

In China, the trade surplus was reported below expectations for August, printing at $20 bn vs. $26.9 bn expected. Export growth was not the main problem but mostly that significantly stronger imports 35.2% vs. 27.5% caused the global recovery bulls to breathe a sigh of relief.

In Japan rhetoric took a holiday as economic data and BoJ minutes did all the taking. The final Q2 GDP estimate was revised up significantly to +0.4% q/q from the previous estimate of +0.1% q/q while Noda stated that economic data confirmed that the recovery had continued through Q2. The BoJ minutes highlit the growing concern that members had about the stronger JPY. However, one member noted that there were benefits of a stronger JPY - the cost of imports would be reduced and Japanese capital could become more competitive in foreign markets, these are ideas we are sure pundits will grab onto. With economic data not collapsing, we suspect that both the MoF and BoJ will stay on the sidelines until at least after the Sept 14th election.

Traders will continue using the JPY as a primary safe haven trade and we are watching for JPY selling as an opportunity to rebuild JPY long positions.

In the UK as was widely expected, the BoE held policy unchanged with no accompanying statement making this a complete nonevent. The market will wait for more economic data and the minutes to rule on the future prospects of the GBP. Risk to the UK economy are clearly balanced with the economic recovery looking very shallow right now - the historically subborn inflation of the Pound has failed to relent.

With more austerity potentially around the corner in the UK and Europe, monetary policy is more likely to be concerned with sovereign EU risk and GBP inflation should the Eurozone recovery continue to underperform against other G10 & EM peers

Today Key Issues:

• 07:30 SEK Jul new orders; prior +15.5% y/y.
• 08:00 EUR ITA Jul ind production, +0.5% m/m, +5.8% y/y exp; prior +0.6%, +8.2%.
• 08:00 NOK Aug CPI, +2.0% y/y exp; prior +1.9%.
• 08:00 NOK Aug CPI - core, +1.4% exp; prior +1.3%.
• 08:00 NOK Aug PPI; prior +18.1% y/y.
• 08:30 GBP Jul PPI - core, 0.1% m/m, +4.6% y/y exp; prior +0.2%, +4.7%.
• 08:30 GBP Jul PPI - input, +0.1% m/m, +8.9% y/y exp; prior -1.0%, +10.8%.
• 08:30 GBP Jul PPI - output, +0.1% m/m, +4.8% y/y exp; prior +0.1%, +5.0%.
• 09:00 EUR ITA Q2 GDP - final, +0.4% q/q, +1.1% y/y exp; prelim +0.4%, +1.1%
• 14:00 USD Wholesale inventories % m/m 0.5 exp; 0.1 prior

The Risk Today:

EurUsd Yet another attempt to challenge 1.2780 resistance fell flat yesterday, with the pair hitting a peak of 1.2766 before succumbing to the bears once more. Unlike Wednesday’s effort however, the ensuing slump managed to break below 1.2660 support (100-day moving average, 1 Sep & 8 Sep lows) so attention now turns back towards the downside. Key supports are eyed at 1.2625 (31 Aug low), 1.2605 (the back side of a former 3-week downtrend), 1.2588 (24 Aug low and range floor), then the 1.2522 (13 Jul low). Should range-trading persist a little longer (and thereby deliver another rally higher), we still see 1.2780 as a key technical level within the range and anticipate sellers to step in as the rally approaches there. Above, the next level is the range ceiling 1.2930 and pretty formidable resistance at 1.3000.

GbpUsd The 2-3 week downtrend channel is still bossing the price action in GBPUSD, and since the brief spike through 1.5525 on Wednesday, the pair has been knocked back into submission below 1.5400. With focus pointed downwards, the next obvious target is the 1.5300 seen late on Tuesday and then the trendline support now seen at 1.5265. If the move extends beyond there, next level is eyed at 1.5235, before major support kicks in at 1.5115-25 (50% fibonacci level and 21 Jul lows). For the bulls to buck the trend, they will first need to conquer trendline resistance now at 1.5510, then 1.5580 (23.6% fibonacci retracement of 1.4229 – 1.6000). Should they achieve the latter, the way is clear for a test of major resistance at 1.5715.

UsdJpy After Wednesday’s false break below 83.60 support, we have failed to get another hourly close below that level to re-activate the descending triangle pattern on the hourly chart (which carries a target of 81.35). We are therefore sat waiting for a decisive move one way or another to influence our strategy; should we finally receive that confirmed break lower, there remains weak 2-month downtrend support at 82.45, but then a barren wilderness of downside not explored since 1995. On the topside the key levels of note are the 85.22 peak from 3 Sep, major resistance at 85.90 and 86.50 (5 Aug high). Our short-to-medium term target remains the 79.75 – 80.00 area where the pair bottomed out 15 years ago (the last time we were down here).

UsdChf It appears the break of the 1-month downtrend yesterday (however passive it may have seemed) has managed to attract some attention, and the market has increasingly started squeezing weak shorts up through 1.0185 resistance and on to challenge 1.0230-40.So far, two attempts to pierce that ceiling have failed, but should supply dry up and the pair move higher, it may activate a double bottom pattern on the hourly chart with a target at1.0415. Nearest resistance is expected up through 1.0310 (30 Aug high), 1.0450-60 (19 Aug & 24 Aug resistance), then 1.0550 (13 Aug high). From here, immediate support is expected at 1.0065 (back side of former downtrend and low from 1 Sep). Despite the latest correction, we still think that a return to parity is inevitable in the coming months; indeed our technical analysis can only offer a few remaining supports at 0.9960 (3 Dec 2009 low) and 0.9920 (26 Nov 2009 low) before USDCHF enters new territory and much greater scope for further CHF strength.